New Technical Analysis Suggests National Economic Slump to Last Until the End of 2016

The United States is well into the fourth year of what economists Carmen Reinhart and Kenneth Rogoff call the Second Great Contraction and economist Robert Hall calls the Great Slump. Only the Great Depression of the 1930s exceeds it in length and severity. While the Great Recession of December 2007 – June 2009 ended over two years ago, the recovery has been characterized by very slow growth and persistently high unemployment. When will the Great Slump end?

Professors Papell and Prodan break the issue down by asking two questions:

1) Do severe recessions associated with financial crises cause permanent reductions in potential GDP, or does the economy return to its trend?

2) If the economy eventually returns to its trend, does the return take longer than the return following recessions not associated with financial crises?

Professors Papell and Prodan develop a statistical methodology that is appropriate for identifying and analyzing slumps, episodes that combine a contraction and an expansion, and end when the economy returns to its trend growth rate.

The research design also includes historically comparable experiences for the U.S. and other advanced economies. They find five economic slumps following financial crises are of sufficient magnitude and duration to qualify as comparable to the current economic situation. These include:

Australia (starting in 1990, lasting 7 ¾ years)

Denmark (starting in 1989, lasting 7 ¼ years)

Finland (starting in 1990, lasting 8 ½ years)

Sweden (starting in 1990, lasting 9 ½ years)

U.S. (starting in 1929, lasting 12 years).

Their research design provides answers to the two questions above. The answer to the first question is “no.” The good news is that the economy will return to its historical trend. However, in answering their second question they find bad news: the time it will take for the U.S. to get back to its historical trend is 9 years. In other words, assuming the slump started in the fourth quarter of 2007 (2007:4), the end will not occur until the fourth quarter of 2016 (2016:4).

Is this scenario plausible? The answer is yes. The projections rely on comparable data and research taken from historical periods for the U.S. and other countries.

What annual growth rate in real GDP would it take to reach the historical trend (potential GDP) by the end of 2016? The answer is 4.16 percent. This is depicted in Figure 1.

How credible is this projected growth rate? The postulated 4.16 percent annual growth rate is lower than the average annual growth rate in the last four years of the slumps for Denmark, Australia, Finland, Sweden, and the U.S. (4.40 percent), although higher than the average excluding the U.S. during the Great Depression, 3.77 percent. It is also consistent with recent CBO projections.